- USD/CAD trades in a tight range even though the US Dollar slides further.
- Rising Fed large rate cut prospects improve the appeal of risk-sensitive assets.
- The BoC may extend the policy-easing cycle next month.
The USD/CAD pair consolidates inside Thursday’s range slightly below the round-level resistance of 1.3600 in Friday’s European session. The Loonie asset remains sideways despite sheer weakness in the US Dollar (USD), suggesting that the Canadian Dollar (CAD) is also performing weakly.
S&P 500 futures have posted decent gains in the European session, exhibiting a strong risk appetite of investors. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, slumps to near 101.00. The appeal of risk-perceived assets has improved as market speculation for the Federal Reserve (Fed) to start the policy-easing process aggressively has strengthened.
The CME FedWatch tool shows that the probability of the Fed reducing interest rates by 50 basis points (bps) to 4.75%-5.00% in September has increased sharply to 43% from 14% on Thursday. Fed large rate cut bets were prompted after the release of the United States (US) Producer Price Index (PPI) data for August, which showed that the producer inflation rose at a slower-than-estimated pace year-on-year.
US core PPI – which excludes volatile food and energy prices – rose steadily by 2.4%, while economists expected the underlying producer inflation to have grown by 2.5%. The headline PPI decelerated to 1.7% from the estimates of 1.8% and the former release of 2.1%. Soft PPI data has diminished fears for price pressures remaining persistent.
Meanwhile, a sharp weakness in the Canadian Dollar appears to be the outcome of firm expectations that the Bank of Canada (BoC) will extend the policy-easing cycle in the October policy meeting. The BoC has already slashed its interest rates by 75 basis points (bps) this year and more rate cuts seem warranted due to lingering growth worries. The Canadian labor market has been hit hard due to the maintenance of a restrictive interest rate stance by the BoC for a longer period.
Canadian Dollar FAQs
The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.
The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.
The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.
While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.
Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.
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